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International Journal of Computer Applications (0975 8887)

Volume 29 No.3, September 2011


24
A Comparison of PNN and SVM for Stock Market Trend
Prediction using Economic and Technical Information

Salim Lahmiri
Dept. of Computer Science
University of Quebec at
Montreal
Montreal, Canada


ABSTRACT
Probabilistic Neural Networks (PNN) and Support vector
machines (SVM) are employed to predict stock market daily
trends: ups and downs. The purpose is to examine the effect of
macroeconomic information and technical analysis indicators on
the accuracy of the classifiers. In addition, the study aims to
study their joint effect on the classification performance when
used together. First, Granger tests were performed to identify
causal relationships between the input variables and the
predicted stock returns. Then, lagged returns to be considered
in the input space are identified by use of autocorrelation
function. Finally, the hit ratio of predictions by P NN a n d
SVM were compared. It is found that macroeconomic
information is suitable to predict stock market trends than the use
of technical indicators. In addition, the combination of the two
sets of predictive inputs does not improve the forecasting
accuracy. Furthermore, the prediction accuracy improves when
trading strategies are considered.
General Terms
Pattern Recognition, Time Series.
Keywords
Probabilistic Neural Networks, Support Vector Machines,
Classification, Stock Market

1. INTRODUCTION
Forecasting stock market behavior is a very difficult task since
its dynamics are complex and non-linear. For instance, stock
return series are generally noisy and may be influenced by many
factors; such as the economy, business conditions, and political
events to name a few. Indeed, empirical finance shows that
publicly available data on financial and economic variables may
explain stock return fluctuations in the United States [1]-[8]. For
instance, a number of applications have been proposed to
forecast stock market returns with macroeconomic variables with
the use of neural networks [9-12] and Bayesian networks and
support vector machines [13][14]. On the other hand, technical
indicators have been also used to predict stock market
movements using neural networks [15-21], adaptive fuzzy
inference system [22][23], and fuzzy logic [24-26]. The literature
shows that economic variables and technical indicators have
achieved success in predicting the stock market. However, none
of the previous studies have compared the performance of the
economic information and technical indicators in terms of
prediction accuracy. Indeed, it is not known what type of
information leads to better forecasts. In addition, one wonders
what would be the effect of combining the two types of
information on the prediction accuracy. Unlike the literature,
only predictive variables that show strong evidence of causal
relationship with return series are considered. In addition, lagged
returns to be considered in the input space are statistically
determined. The purpose of this study is to predict stock market
trends (ups and downs) with macroeconomic variables and
technical indicators separately and jointly in order to compare
the performance of the classifiers. For instance, two classifiers
are employed. They are the probabilistic neural networks (PNN)
and support vector machines (SVM).
The PNN provides a general solution to pattern classification
problems based on Bayesian theory. It is chosen because of its
ability to classify a new sample with the maximum probability of
success given a large training set using prior knowledge [27].
The PNN combines the simplicity, speed and transparency of
traditional statistical classification models and the computational
power and flexibility of back-propagated neural networks [28].
On the other hand, SVM are expressed in the form of a hyper-
plane that discriminates between positive and negative instances.
This is achieved by maximizing the distance between the two
classes (positive and negative instances) and the hyper-plane.
The SVM are applied in this study since they can avoid local
minima and have superior generalization capability [29].
The rest of the paper is organized as follows. The data and pre-
processing, and classifiers are presented in section 2. In Section
3, the results are provided. Section 4 contains the concluding
remarks.
2. METHODOLOGY
2.1 Data and pre-processing
The initial sample consisted of the S&P500 daily returns as well
as economic variables, all from January 11, 2000, to January 31,
2008, with no missing values. The economic variables were
obtained from the FRED database of the Saint-Louis Federal
Bank [30]. Given that the objective of the study was to predict
future daily stock returns (R
t+1
), the continuously compounded
rate of return is computed on a daily basis as follows:
International Journal of Computer Applications (0975 8887)
Volume 29 No.3, September 2011
25
|

\
|
=
1
log
t
t
t
p
p
R
where p is the price of the S&P500 index. Figure 1 exhibits the
S&P500 return series (R
t
). Tables 1 and 2 show the economic
variables and technical indicators that were employed for the
prediction task. The choice of these primary predictive inputs is
based on their frequent use in the literature [1-26].
-0.03
-0.02
-0.01
0
0.01
0.02
0.03

Fig. 1. Return series of the S&P500 Index.
Table 1. List of macroeconomic variables
Variables Description
DBAA Moody's Seasoned Baa Corporate Bond Yield
DTB3 3-Month Treasury Bill: Secondary Market Rate
DTB6 6-Month Treasury Bill: Secondary Market Rate
DFEDTAR Federal Funds Target Rate
DFF Effective Federal Funds Rate
DEXCAUS Canada / U.S. Foreign Exchange Rate
DEXJPUS Japan / U.S. Foreign Exchange Rate
DEXSZUS Switzerland / U.S. Foreign Exchange Rate
DEXUSEU U.S. / Euro Foreign Exchange Rate
DEXUSUK U.S. / U.K Foreign Exchange Rate
DTWEXB Trade Weighted Exchange Index: Broad
DTWEXM Trade Weighted Exchange Index: Major Currencies

Table 2. List of technical indicators
Indicators Description
MA(t) moving average
X1(t) [X(t) - lowest price(t)] / [(highest price(t) - lowest
price(t)]
X2(t) [X(t) - MA(t)] / MA(t)
X3(t) X(t) - MIN[X(t),,X(t-5)]
X4(t) X(t) - MAX[X(t),,X(t-5)]
MPM(t) [(highest price(t)-lowest price(t))-(highest price(t-
2)-lowest price(t-2))]/2
BR(t) volume(t)/[(highest price(t) - lowest price(t))/2]
EMV(t) MPM(t)/BR(t)
MOM(t) closing price (t) - closing price (t-6)
ROC(t) closing price (t) / closing price (t-6)
DIS(t) [closing price (t) / MA(t-6)]*100
STOD(t) [closing price(t) - low price(t,t-6)]/ [high price(t, t-
6) low price(t,t-6)]
Unlike previous studies [9-26] and in order to improve the
coherence of the input-output mapping, Granger tests [31]
were performed to identify causal relationships between
predictive inputs and future stock returns. As a result, only
statistically causal inputs are retained and the number of
dimension in the input space is reduced. For instance, the
relevant inputs were selected by first running Granger causality
tests on the macro economic variables and technical indicators.
Since correlation does not necessarily imply causation, the
Granger test was employed to investigate whether x (the macro
variables or the technical indicators) causes y (the stock returns
in this work). This simple statistical approach is about seeing
how the current y can be explained by past values of x and
then whether adding k lagged values of x can improve the
explanation. In other words, y is said to be Granger-caused by
x if x helps forecast y. The Granger test allows considering only
inputs that have a high statistical causal effect on future stock
returns. The test is based on bivariate regressions of the
form:
t k t k y t y k t k x t x x t
t k t k x t x k t k y t y y t
y y x x x
x x y y y


+ + + + + + + =
+ + + + + + + =


, 1 1 , , 1 1 , 0 ,
, 1 1 , , 1 1 , 0 ,
... ...
... ...
where and represent Gaussian disturbances. Then, F-
statistics are computed as the Wald statistics [28] for the joint
hypothesis:
0 ...
2 1
= = = =
k

The F-statistics allows testing whether the coefficients on the
lagged xs are statistically significant in explaining the
dependant y. In this study, the number of lags, k, was set to 5
and the retained statistical significance is 5%. Tables 3 and 4
provide the obtained results from the Granger causality tests
for macroeconomic variables and technical indicators
respectively.
Table 3. Granger tests for macro variables
Null Hypothesis F-Stat. Probability
DAAA does not Granger Cause R 0.95143 0.4465
DBAA does not Granger Cause R 1.16856 0.32223
DEXCAUS does not Granger Cause R 1.06268 0.37919
DEXJPUS does not Granger Cause R 1.44641 0.20448
DEXSZUS does not Granger Cause R 2.57318 0.02498
DEXUSEU does not Granger Cause R 1.4195 0.21401
DEXUSUK does not Granger Cause R 1.23676 0.2892
DFEDTAR does not Granger Cause R 1.0858 0.36616
DFF does not Granger Cause R 3.07175 0.00911
DTB3 does not Granger Cause R 0.26302 0.93331
International Journal of Computer Applications (0975 8887)
Volume 29 No.3, September 2011
26
DTB6 does not Granger Cause R 1.21703 0.29847
DTWEXB does not Granger Cause R 2.08736 0.06423
DTWEXM does not Granger Cause R 1.72344 0.12589
Table 4. Granger tests for technical indicators
Null Hypothesis F-Statistic Probability
BR does not Granger Cause R 0.24284 0.94345
DIS does not Granger Cause R 1.58049 0.16224
EMV does not Granger Cause R 2.22486 0.0494
MOM does not Granger Cause R 1.00126 0.41542
MPM does not Granger Cause R 1.48907 0.1901
ROC does not Granger Cause R 0.98104 0.42785
STOD does not Granger Cause R 0.68897 0.63181
X1 does not Granger Cause R 0.95859 0.44194
X2 does not Granger Cause R 1.58049 0.16224
X3 does not Granger Cause R 1.04415 0.38987
X4 does not Granger Cause R 2.64313 0.02173
Granger causality tests show strong evidence that
DEXSZUS, DFF, EMV, and X4 cause changes in S&P500
returns. For instance, the null hypothesis is rejected with
probability 0.02498 for DEXSZUS, with probability 0.00911
for DFF, with probability 0.0494 for EMV, and with
probability 0.02173 for X4. Thus, two macroeconomic
variables (DEXSZUS and DFF) and two technical indicators
(EMV and X4) are selected to be fed to the classifiers as
inputs. For example, the PNN and SVM are trained and
tested with these resulting data. The first 80% of the data
(1620 observations) were used for model training while
the last 20% (405 observations) were used for out-of-sample
forecasting. Cross validation is not considered since the goal
of this study is to model time series and no future
observations are used to predict past ones. The variable to be
predicted is stock market future trends. Then, the output
becomes:
{ } 0 1 ; 0 1 > + < =
t t t
R if R if y
In order to test what type of information (macroeconomic
variables versus technical indicators) provide higher accuracy
rate, and whether the combination of the two type of
information helps improving the prediction accuracy, the
following prediction models (PM) are considered:

Model.1:
) , , , , (
1 1 2 1
=
t t k t t t t
DFF DEXSZUS R R R f y K
Model.2:
) , , , , , (
7 1 2 1
X EMV R R R f y
t k t t t t
= K
Model.3:
) , , , , , , , (
7 1 1 1 2 1
X EMV DFF DEXSZUS R R R f y
t t t k t t t t
= K

where t is time script and k is a lag order which is determined
using the auto-correlation function given by:
( )( ) ( )
1
1
2
1

= + =
(

=

T
t
t
T
k t
k t t k
R R R R R R
where R is the sample mean of R
t
. The appropriate k is
determined following the methodology of [32][33]. Indeed, it
is important to include past returns to predict future market
directions if the return series are auto-correlated. In other
words, history of the returns helps predicting future returns.
Figure 2 shows the auto-correlation function up to 10 lags.
Since is nonzero for k=1 and k=2, it means that the series is
serially correlated. In addition, the values of the auto-
correlation function die quickly in the first three lags which is a
sign that the series obeys a low-order autoregressive (AR)
process; for example an AR(2). Therefore, the number of lags
to be included in the prediction models is up to k=2. Finally,
the following prediction models (PM) are implemented and
simulated:
PM.1:
) , , , (
1 1 2 1
=
t t t t t
DFF DEXSZUS R R f y
PM.2:
) , , , (
7 1 2 1
X EMV R R f y
t t t t
=
PM.3:
) , , , , , (
7 1 1 1 2 1
X EMV DFF DEXSZUS R R f y
t t t t t t
=

International Journal of Computer Applications (0975 8887)
Volume 29 No.3, September 2011
27

Fig. 2. Auto-correlation function
k
of S&P500 returns at
different lags k [1,10].

2.2 The classifiers
2.2.1 Probabilistic neural networks
The PNN was proposed by Specht [28]. It is built based upon
the Bayesian method of classification. Indeed, the PNN employs
Bayesian decision-making theory based on an estimate of the
probability density of the data. The probabilistic neural network
requires only a single presentation of each pattern. The PNN
employs an exponential activation function rather than the
sigmoid function that is commonly used in the multi-layer
perceptron. Then, PNN can identify nonlinear decision
boundaries that approach the Bayes optimal [34]. The basic
network topology consists of four layers. The first layer is the
inputs layer. In the second layer, the probability density function
(PDF) of each group of patterns is directly estimated from the
set of training samples using [35] window approximation
method. The third layer performs the summation of all PDFs.
Finally, the Bayesian decision is made in the fourth layer. In
sum, the network structure of PNN is similar to back-
propagation neural network; but the main difference is that the
transfer function is replaced by exponential function and all
training samples are stored as weight vectors. For instance, the
PDF is assumed to follows a Gaussian distribution. Then, the
PDF for a feature vector X to be of a certain category A is given
by:
( ) ( ) ( ) ( ) ( )

\
|

=
m
i
Ai Ai
p p
A
X X X X m X f
1
2 1 5 . 0
2 exp 2 1

where, p is the number of patterns in X, m is the number of the
training patterns of category A, i is the pattern number, and is
the smoothing factor of the Gaussian curves used to construct
the PDF. The value of is optimized during training based on
the clearest separation of classes with the highest classification
rate [36].

2.2.2 Support vector machines
Support Vector Machines (SVM) is a supervised statistical
learning technique introduced by Vapnik [29]. It is one of the
standard tools for machine learning successfully applied in many
different real-world problems. For instance, they have been
successfully applied in financial time series trend prediction
[14][37]. The SVM were originally formulated for binary
classification. The SVM seek to implement an optimal marginal
classifier that minimizes the structural risk in two steps. First,
SVM transform the input to a higher dimensional space with a
kernel (mapping) function. Second, SVM linearly combine them
with a weight vector to obtain the output. As result, SVM
provide very interesting advantages. They avoid local minima in
the optimization process. In addition, they offer scalability and
generalization capabilities. For instance, to solve a binary
classification problem in which the output y{-1,+1} SVM seek
for a hyper-plane w.(x)+b = 0 to separate the data from classes
+1 and 1 with a maximal margin. Here, x denotes the input
feature vector, w is a weight vector, is the mapping function
to a higher dimension, and b is the bias used for classification of
samples. The maximization of the margin is equivalent to
minimizing the norm of w [38]. Thus, to find w and b, the
following optimization problem is solved:

=
+
n
i
i
C w Minimize
1
2
:
( ) ( ) n i b x w y t s
i i i i
, , 1 0 1 . K = +
where C is a strictly positive parameter that determines the
tradeoff between the maximum margin and the minimum
classification error, n is the total number of samples, and
generalization and is the error magnitude of the classification.
The conditions ensure that no training example should be within
the margins. The number of training errors and examples within
the margins is controlled by the minimization of the term:

=
n
i
i
1

The solution to the previous minimization problem gives the
decision frontier:
( ) ( ) ( ) b x x y x f
i
x
i i i
+ =


where each
i
is a Lagrange coefficient. As mentioned before,
the role of the kernel function is to implicitly map the input
vector into a high-dimensional feature space to achieve better
separability. In this study the polynomial kernel is used since it
is a global kernel. For instance, global kernels allow data points
International Journal of Computer Applications (0975 8887)
Volume 29 No.3, September 2011
28
that are far away from each other to have an influence on the
kernel values as well [39].
( ) ( ) ( ) ( ) ( )
d
i i i
x x x x x x K 1 , + = =
where the kernel parameter d is the degree of the polynomial to
be used. In this study, d is set to 2. Finally, the optimal decision
separating function can be obtained as follows:
( )
|
|

\
|
+ =

=
b x x K y sign y
n
i
i i i
1
,
3. RESULTS
The accuracy is calculated based on the number of correct
classifications (Hit Ratio). For example, 100% accuracy is
where all records are properly classified and 0% accuracy is
where none are properly classified. The results obtained from
simulation are shown in Figure 3. They show that the PNN
achieved its highest and lowest accuracy with technical
indicators (54%) and macroeconomic information (53%)
respectively. In addition, the simulations show that the best
performance (64%) is obtained with support vector machines
when macroeconomic information is fed to the classifier. On
the other hand, the lowest performance (49%) is achieved by
support vector machines when technical indicators are used as
inputs to the classifier. The findings suggest that the
performance of each classifier depends on the type of input.
For instance, PNN performs best with technical indicators,
whilst SVM perform best with economic information.

Fig. 3. Classification accuracy
Finally, the performance of both PNN and SVM decreases
when macroeconomic information and technical indicators are
fed to the classifiers. Then, the combination of macroeconomic
information and technical indicators does not help to improve
the prediction accuracy. Although the prediction accuracy is
low, the overall results are interesting since some previous
studies reported that stock prices are approximately close to the
random walk process and; consequently; an accuracy of 56%
in the predictions is a satisfying result for stock forecasting
[40]-[43]. However, it is possible to improve the accuracy if
we consider two investment strategies. The first strategy is to
predict stock market ups by more than a predetermined rate,
and the second strategy is to detect downs by less than another
predetermined rate. Indeed, investors act as if they extrapolate
a positive price trend by overbuying winners [44]. Therefore,
they are likely to follow a momentum investment strategy and
buy winners [45]-[47]. Then, in order to improve the prediction
of the future trend in S&P500, two trading strategies are
defined. For instance, the output of PNN is defined according
to two strategies as follows:
Strategy.1:
{ } % 5 . 0
,
1 ; % 5 . 0
,
0
,
< =
t i
R if
t i
R if
t i
y
Strategy.2:
{ } % 5 . 0
,
; % 5 . 0
, ,
0 1 > =
t i
R if
t i
R if
t i
y
The first strategy is designed to detect S&P500 ups by more
than 0.5%. This strategy is designed for an aggressive investor
who is a risk-taker. On the other hand, the second strategy is
designed to detect S&P500 downs by less than 0.5%. It is
designed for a risk-averse investor who dislikes losses. The
thresholds 0.5% and -0.5% are arbitrarily chosen. For the
classification task, the PNN is considered since it employs
Bayesian decision-making theory which is more suitable to
estimate the probability of future gains (strategy 1) and losses
(strategy 2). The forecasting performance of the PNN given each
strategy is shown in Figure 4.

Fig. 4. Classification accuracy given strategies 1&2
The simulation results show that the accuracy increases in
comparison with the results provided in Figure 3. In addition,
the best accuracy is obtained with macroeconomic information
(88.84%) when strategy 1 is adopted. On the other hand, the
lowest accuracy is obtained with technical indicators (82.79%)
when strategy 2 is adopted. As a result, macroeconomic
information is more suitable for both risk-taker and risk-averse
investors. In other words, economic information has proven its
superiority in stock market prediction than technical indicators.
Finally, in both strategies the combination of macroeconomic
information and technical indicators does not help improving
the performance of the prediction system.
International Journal of Computer Applications (0975 8887)
Volume 29 No.3, September 2011
29
4. CONCLUSION
The purpose of this study is to predict stock market trends (ups
and downs) with macroeconomic variables and technical
indicators separately and jointly using intelligent and statistical
systems. Indeed, the contribution is to examine the effect of each
type of predictive inputs; and also their combination; on the
classification accuracy. Another contribution in this study is to
consider a better selection of the predictive variables. For
instance, unlike previous literature [14][48]-[52] that focus on
the prediction of ups and downs of stock markets; Granger
causality tests are performed to identify inputs (macroeconomic
information and technical indicators) that statistically cause
changes in stock returns. In addition, lagged returns -that will
form the input space along with inputs selected by Granger tests-
are statistically identified by use of auto-correlation function. In
other words, the number of lagged returns as predictive variables
is not set arbitrarily.
In this work the S&P500 returns are studied through
probabilistic neural networks (PNN) and support vector
machines (SVM). As shown in the experiments, PNN performs
best with technical indicators, whilst SVM perform best with
economic information. In addition, the combination of
macroeconomic information and technical indicators does not
help to improve the prediction accuracy. However, the best
accuracy is obtained accuracy is obtained with SVM using
economic information (64%). Although the prediction accuracy
is low, the overall results are interesting since some previous
studies reported that stock prices follow a random walk process.
To improve the accuracy, two trading strategies are defined. The
first trading strategy is designed for risk-taker investors to detect
S&P500 ups. The second trading strategy is designed for risk-
averse investors to detect S&P500 downs. As a result, the
accuracy increased up to 88.84% and 83.26% for strategy 1 and
strategy 2 respectively. In addition, the simulations show that for
both strategies, economic information provides more accurate
predictions than technical indicators. Furthermore, the
combination of macroeconomic information and technical
indicators does not help improving the performance of the
prediction system in both trading strategies.
In sum, both PNN and SVM confirm that macroeconomic
information is suitable to predict stock market trends than the use
of technical indicators. This finding is explained by the fact that
economic theory provides strong economic models relating stock
market behaviour to the economy cycles and conditions [1-8].
On the other hand, technical analysis suffers from lack of
theoretical foundations. For future researches, a large set of stock
markets would be considered to validate the results. Also, the
performance of the SVM with different polynomial orders would
be investigated for each trading strategy.
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